Better Than Gold
November 17, 2011
Farmland values are up again across the country, and with strong commodity prices, land prices seem sure to post sizeble gains well into the future. For farmers coming off two decades of tight margins, the strength in the land market is not only helping them sleep at night, it's actually giving them fun options to dream about.
But how do farmland investments compare to other vehicles? In other words, should you be investing in mutual funds or blue chips, or even in gold instead?
Marvin Painter, head of the department of management and marketing at the Wilson Centre for Entrepreneurial Excellence at the University of Saskatchewan doubts you'll do much if any better anywhere else.
"Farmland investment yields and risk are most similar to high-dividend-yielding blue-chip stocks," Painter says, and then adds, "Farmland is better than gold."
Painter isn't the only economist to compare farmland to other investment options, but he's considered an expert on land valuations in Canada, and he's bullish on land.
In fact, not only does the upside look good on farmland, the downside favours farmland too. Farmland in a Real Estate Investment Trust (REIT) has about half the risk of the stock market, Painter says. "Right now sky-high gold values are boosting the average long-term ROI but the risk is higher too."
Basically, Painter calculated the impact Canadian farmland would have had in an investment portfolio for the period 1990 to 2007. Again and again, he found that farmland significantly improved the portfolios, if risk was weighted into the calculation. Farmland investment yields proved very similar to average North American stock market yields, bonds and even oil.
Painter started doing these comparisons a decade ago by asking how farmland would fit and match up with all the other types of investments in a portfolio. His calculations consider rent as a kind of dividend and they predicted capital gains from future land sales for the period 1972 to 2007 based on Canadian averages.
Similar pictures have been painted for farmland in the U.S. In 2000, Terry Kastens and Kevin Dhuyvetter from Kansas State University compared broad farmland returns to the Standard &Poor 500 average from 1951 to 1999. When combining real returns and capital gains, farmland returned 10 to 12 per cent (about five per cent when adjusted for inflation) for non-leveraged properties.
In the same period, they note, the Standard &Poor nominal return with dividends included was 14.3 per cent (not adjusted for inflation), while its dividend-only return was four per cent. Like Painter, the study's authors viewed cash rents as farming's equivalent to dividends.
As well, the National Council of Real Estate Investment Fiduciaries calculates a Farmland Index. Their composite quarterly return is a measure of actual investment performance of a large pool of individual agricultural properties bought in the private market for investment purposes only. All properties in the Farmland Index have been acquired, at least in part, on behalf of tax-exempt institutional investors, mostly pension funds.
The council's return-on-land calculation also includes appreciation and income from renting to farmers. Last year for the corn belt it was estimated to be 14 per cent.
"As the Canadian farm sector continues to change, farmers must realize that they're real estate investors just as much as farm commodity producers," says Painter.
There's an important word of caution, however. What farmers shouldn't do is apply Painter's work to a specific section or farm. This is big-picture analysis. He looked at average farmland values across Canada and some of his assumptions may not apply to specific areas. For example, Painter assumed a four per cent operating yield — essentially what farmers might earn from cash rent in some areas of the Prairies. However, in some parts of the West, rents are lower, as they are in Ontario where the cash rent can be below two per cent of value, and where 20 per cent share agreements are rare.
Not only that, but the implications for investing in farmland for most farm families are a lot different than for their cousins in town dabbling in some mutual funds. For individual family farms, the consequences of land purchases directly affect how their family lives. Decisions involve long-term projections and substantial capital investment.
Plus, you don't have to have farmed very long to know some years, the carrying capacity trumps ROI.
Even so, land is proving to be a long-term relatively safe asset that generates yields.
Enter the funds
"For a non-farmer investing in a FREIT, farmland is considered low risk," Painter says. "Somewhere between long-term bonds and blue-chip stocks."
As well, the low, negative correlation of farmland yields with stocks and bonds makes it a good candidate for portfolio diversification, especially with Wall Street's wonkiness in the last few years.
Also, farmland has capital gain yields. However, for non-farm investors, outright purchase of farmland has some drawbacks such as having to manage the lease, less liquidity than financial assets and lumpiness of the asset units. Farmland is illiquid and expectations for profit can be too high.
Painter recognizes these limits but his main message is for investors to use land for risk diversification. "Farmland is a good option for mid-range risk portfolios — which describes the majority of investors," he says.
Conversely, he also says farmers should consider owning stocks and bonds to diversify their farmland holdings, and that when expanding they should consider leasing instead of purchasing more farmland. Other investments can help balance the risks associated with farming and farmland investments, depending on the stage of the farmer.
Of course, this is a very individual decision, depending on the stafe of the farmer, their risk aversion and the concentration and size of their holdings. "In general for an individual farmer, the risk (to buying farmland) is still pretty high," says Painter.
Still more upside?
According to Farm Credit Canada's farmland value report, the average value of farmland across Canada rose by 5.1 per cent in 2010, spurred on by cash crop producers. Strong demand with limited supply made farmland a hot commodity due to its historic performance as a stable investment and its current income-generating potential.
FCC surveys show Canadian farmland values have risen steadily during the last decade. The highest average national increase was in 2008 at 7.7 per cent. The last time the average value decreased was in 2000 at -0.6 per cent.
Low interest rates also encouraged buyers to seize opportunities and influenced farmland values upward. Although it seems more buyers are interested in purchasing farmland, supply is limited. This continues to fuel competition in the farmland market.
However, in Painter's calculations, interest rate isn't accounted for as it's considered a management decision, irrelevant to investment. It's an operating business decision, financed any way you want, whether that's an outright purchase or taking on debt, so interest is separate from ROI calculations.
Farmers are now competing for land against funds with many land packages spread across many locations and crops, which gives the farmland funds a risk advantage. In Painter's work, risk is a significant factor but he concludes that it doesn't matter if the spread was across the country or within a province as long as both weather and crop types are diversified.
Farmland fund managers are banking on investors looking for somewhere safe to plunk their money to ride out the stock market storms. In that context, farm commodity markets are among the few economic good news stories. "In today's market everybody's looking around for what to invest in," says Painter.
Not only are the fund companies looking, they're buying.
Global investment funds have pumped an estimated $20 billion into these acquisitions. In 2009, they bought 111 million acres of farmland, a tenfold increase from previous years. However, the amount of farmland held by only a handful of funds in Canada is still relatively small.
Hancock Agriculture, a unit of Manulife Financial Corporation, has a $1.3-billion farmland fund and controls 201,000 hectares in the U.S., but owns only about 2,500 acres in Canada.
Assiniboia Capital Corporation now manages the largest farmland fund in Canada, with over 110,000 acres owned and under management. "We prefer cash rent deals and our leases tend to be from three to five years, depending on the circumstances related to the specific property," says Brad Farquhar, vice-president of Assiniboia.
Ag Capita is a Calgary-based fund and claims to have $100 million in farm assets, and Sprott Resources with their One Earth Farm is targeting 90,000 hectares this year, although those may or may not be land purchases.
Prairie Merchant (owned by famed Dragon Den's Brent Wilson) reportedly bought 20,000 acres last year and a new Ottawa-based publicly traded fund, Bonnefield, began buying farmland in April 2010 and now owns 7,500 acres across the Prairies and Ontario.
A new kind of value
Considering there's nearly 65 million acres of farmland in Saskatchewan alone, the fund-owned part is small but it does inject new buyer interest into an already high-demand, limited-resource market. Moreover, people like Painter or the fund managers have brought a new way of looking at land values.
Bonnefield has basically created a price-to-earnings matrix for farmland. Their techies layered soil maps, climatic and yield data on a GIS map along with farmland values. That's how they compare regions to pinpoint where land at similar productive capacity is trading at a discount, right down to the municipality level.
Farmers know that the price-to-earnings ratio for farmland is generally pretty lopsided, unless it's very undervalued. However, we also know that a few years of high grain and oilseed prices with excellent crop yields can pay for a lot of land.
"Smart investors look for under versus overvalued assets relative to earning potential," says Painter.
Additionally, farmland is being viewed as an effective hedge against inflation, and agricultural production is seen as a bright light in investment circles. World shortages of food and government-mandated ethanol markets should continue to drive commodity markets, setting up forecasts of strong farm profits which will in turn drive land values.
"The bottom line (for land values) is on-farm profits," says Painter. "It's impossible to predict but considering these factors, there's still an upside to land values, especially in some parts of Canada."CG
Production and profit are still the major drivers for land value but other factors are becoming more and more important, particularly politics. The most obvious example is in Saskatchewan, where restrictive ownership rules have kept land prices artificially low.
Ironically those low prices are making the province the focus of many farmland fund companies.
In theory, urbanization should increase farmland values. However, recent work by economists Richard Vyn and Brady Deaton at the University of Guelph has shown that legislation can alter this natural state. They studied what has happened to farmland values in the Greater Toronto Area since the Greenbelt legislation was enacted in 2004, prohibiting development.
"Once you jump over that protected area and you're within commuting distance, prices increase again," says Vyn. "Within five kilometres from the GTA, values are down 30 per cent."
Although the politicians said the Greenbelt wouldn't affect land values, and that it would strengthen rural communities and enhance the environment, it turns out that farmers near the urban centres were right to be concerned. Developers have simply jumped the Greenbelt and built houses for commuters on the other side.
Now the Ontario government is once again considering an expansion of the Greenbelt boundary beyond its current 1.8 million acres.
City greenbelts are intended to concentrate growth and stop sprawl. As the land in these leapfrog areas increases in value, the suburbs and horses move in and the farmers move even farther out. Numerous studies from around the world, from Seoul to the United Kingdom have shown similar repercussions. Urban sprawl still happens, just not in the same place.
- Source: Maggie Van Camp, AGCanada.com
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